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Updated Feb 14, 2024

What Is GAAP? A Guide to Generally Accepted Accounting Principles

Learn how GAAP principles work and what that means for your business.

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Jamie Johnson, Senior Analyst & Expert on Business Operations
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If you run a small business, you may not know much about the Generally Accepted Accounting Principles (GAAP). After all, GAAP standards apply to publicly traded companies, so these rules don’t always feel relevant to your small business.

However, it’s a good idea to have a basic understanding of GAAP standards. This information will help you improve your accounting skills, understand accounting principles and pinpoint how your business should track and measure its financial information. 

Editor’s note: Looking for the right accounting software for your business? Fill out the below questionnaire to have our vendor partners contact you about your needs.

What is GAAP?

GAAP refers to the rules and standards used for financial reporting in the United States. GAAP standards were developed by the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB). These standards apply to corporate, government and nonprofit accounting

The U.S. Securities and Exchange Commission (SEC) requires all publicly traded companies to adhere to GAAP standards. When each company reports and maintains its financial records the same way, it’s easier for investors to compare companies to make investment decisions. 

GAAP requires publicly traded companies to adhere to these four standards:

  • Recognition: Financial statements should accurately reflect your company’s assets, liabilities, revenue and expenses.  
  • Measurement: Financial statements should measure your organization’s financial results in accordance with GAAP standards. 
  • Presentation: For each reporting period, your business will present an income statement, balance sheet, cash flow statement and statement of shareholder’s equity
  • Disclosure: All financial statements will include any notes necessary to help users interpret the information. 
FYIDid you know
Even if you employ an accountant or bookkeeper, understanding GAAP standards helps business owners ensure accurate and transparent financial reporting.

What are the 10 principles of GAAP?

These 10 principles can help you understand the purpose of GAAP:

  1. Principle of regularity: Your accountant has followed all GAAP rules and regulations.
  2. Principle of consistency: Accountants commit to using the same standards from one period to the next. This consistency makes it easier to avoid errors and ensure financial comparability. If your accountant must make a change, they will disclose why in the footnotes. 
  3. Principle of sincerity: Your accountant will provide an impartial and accurate view of your company’s financial situation. 
  4. Principle of permanence of methods: There should always be a focus on consistency in the methods used during the accounting cycle.
  5. Principle of noncompensation: Your accountant will report all financial information transparently, outlining the positives and negatives. This report is made without the expectation of debt compensation. 
  6. Principle of prudence: All financial data is reported as it currently is, without any speculation.
  7. Principle of continuity: This principle takes the assumption that your business will continue to operate in the future.  
  8. Principle of periodicity: All accounting entries are reported during the appropriate periods. For example, both revenue and expenses will be reported during the correct periods. 
  9. Principle of materiality: Your accountant will disclose all accounting information in the financial reports accurately. 
  10. Principle of utmost good faith: This principle states that all parties will remain honest in their transactions. 
Did You Know?Did you know
To hire the right accountant for your business, seek out someone with appropriate experience who can explain accounting concepts clearly.

The importance of GAAP compliance

If you run a publicly traded company, the SEC requires that your business follows GAAP standards. You must complete GAAP-compliant financial statements to remain listed on the stock exchanges. 

GAAP compliance is not required for private companies but most lenders prefer it. If you plan to apply for a small business loan, you may be required to file GAAP-compliant financial statements. 

Additionally, investors are often wary of businesses that don’t follow GAAP standards. That’s because the consistency of GAAP principles makes it easier to compare financial statements. In case your company ever goes public, you should begin adopting GAAP standards now. 

Non-GAAP reporting and limitations of GAAP

GAAP standards are based on principles like accrual accounting, revenue recognition and expense matching. However, some believe financial statements prepared according to GAAP standards don’t always reflect a company’s performance accurately.  

For that reason, some companies supplement their financial reports with non-GAAP statements, often referred to as pro forma statements. The goal is to present a more accurate and complete view of the company’s underlying operations.

Non-GAAP statements can include the following:

  • Free cash flow
  • Earnings before interest and taxes (EBIT)
  • Earnings before interest, taxes, depreciation and amortization (EBITDA)
  • Adjusted earnings
  • Funds from operations

Proponents of non-GAAP reporting argue that including this information presents a more nuanced view of the company to investors. Critics argue that using non-GAAP financial statements could result in fraudulent reporting. In particular, the SEC has issued a statement advising caution when it comes to pro forma statements.  

TipBottom line
Most companies operate on either a cash or accrual accounting basis. Cash-basis accounting records revenue after the business receives the cash. In contrast, accrual accounting records revenue after a buyer receives the goods or services ― whether or not the company has received payment.

Best accounting software for GAAP compliance

The best accounting software solutions are designed in accordance with GAAP principles and can help simplify your financial accounting. Many accounting platforms are affordable, easy to use and integrate with your other business software. 

We’re highlighting the following options to help you choose the right accounting software and ensure GAAP compliance:

  • QuickBooks: QuickBooks Online is one of the most popular accounting options for small business owners. It’s an excellent option for businesses of all sizes ― you can start with essential features in the beginning and continue adding more as your business grows. Our QuickBooks Online review explains how to use the software to collaborate with your accountant and generate GAAP-friendly reports.  
  • Xero: Xero’s cloud-based software is easy to use, has more than 1,000 app integrations and can help you comply with GAAP and various regulatory requirements. Every subscription plan allows unlimited users. Read our in-depth Xero review to learn about its mobile app and robust reporting features.   
  • Freshbooks: Freshbooks is another excellent option that can help you or your accountant prepare GAAP-compliant financial statements. Its custom invoice creation tools stand out. Its mobile app will alert you once an invoice has been viewed and you can answer customer questions directly within the app. Our Freshbooks review details the platform’s pricing and additional functionality. 

GAAP FAQs

GAAP standardizes the financial reporting process and creates a common accounting language that all U.S.-based businesses can follow. It ensures that all companies follow the same reporting procedures, making it easier for investors to understand and compare financial statements. GAAP requires all companies to report their financial data fairly and accurately. Maintaining GAAP standards makes it easier to trust the financial market and invest in companies.
GAAP is required for all publicly traded companies in the United States. However, many private companies also follow these standards. GAAP standards apply to all corporate, nonprofit and government accounting practices.
The FASB and the GASB created GAAP standards in response to the 1929 stock market crash and the Great Depression. At the time, many publicly traded companies were not always accurate in reporting their financial data, which likely contributed to the stock market crash. GAAP was later established under the Securities Act of 1933 and the Securities Exchange Act of 1934.
If you aren’t a publicly traded company, following GAAP standards may not be necessary. However, all businesses should be familiar with these five basic accounting principles:
  • Revenue recognition principle: This principle states that any revenue should be recorded once your buyer receives the good or service your company provides ― not after your business is compensated. This is what’s known as accrual accounting.
  • Cost principle: Your accountant should record an expense when your company accepts goods or services from another business ― whether they’ve paid for the transaction.
  • Matching principle: All expenses should match the revenue received during a given accounting period. If your company receives revenue, it should also acknowledge the associated costs.
  • Full disclosure principle: Financial statements should include accurate and complete information so stakeholders know all relevant information about your company.
  • Objectivity principle: All accounting data should be fact-based and free of assumptions. All financial data should be supported by receipts, invoices and vouchers.
International Financial Reporting Standards (IFRS) is a set of accounting principles for publicly traded companies. IFRS is issued by the International Accounting Standards Board (IASB) and has been adopted by 120 countries ― including those in the European Union. These rules are designed to increase consistency and transparency for publicly traded companies worldwide. Like GAAP, IFRS outlines how companies should maintain their financial records and report income and expenses. It creates a global accounting language that investors, auditors and government regulators can understand. Public companies in the U.S. must follow GAAP standards. While the SEC has expressed interest in switching to IFRS, there's been no real movement.
Here's a breakdown of the primary differences between IFRS and GAAP:
IFRS GAAP
Issued by the IASB Issued by the FASB
Doesn’t allow last-in, first-out (LIFO) method to estimate inventory Uses LIFO or first-in, first-out (FIFO) to estimate inventory
Intangible assets are assessed for their future economic benefit Intangible assets are measured for their fair market value
Allows companies more room for interpretation on financial statements Follows a specific set of rules and procedures on financial statements
Revenue can be reported once value is delivered Revenue can be reported once goods or services are received
Groups all liabilities together Groups liabilities as either current or noncurrent
Here is additional information about the primary differences between GAAP and IFRS:
  • Inventory reporting: One of the most significant differences between GAAP and IFRS is how the two standards treat inventory reporting. With IFRS, you can't use the LIFO method to measure inventory. IFRS standards maintain that LIFO doesn’t portray inventory flow accurately and could make your company’s income appear lower than it is. In comparison, GAAP standards allow your company to track its inventory using either LIFO or FIFO.
  • Intangible assets: GAAP and IFRS approach intangible assets differently. Under IFRS, intangible assets can be recognized if they offer a future economic benefit to your firm. However, GAAP recognizes intangible assets at their current fair market value ― without any additional assessment.
  • Financial reporting: GAAP standards follow a highly specific set of rules and procedures with little room for interpretation. These rules are designed to prevent accountants from inflating your business’s financial records to mislead investors. However, IFRS would give your company more room for interpretation in your financial reporting.
  • Revenue recognition: GAAP has specific standards for recognizing revenue across different industries. Generally, revenue cannot be reported until the buyer receives the goods or services purchased from your organization. IFRS states that revenue can be recognized once the value is delivered to your clients.
  • Liabilities classification: Under GAAP standards, liabilities are classified as current or noncurrent depending on how long your business has to repay its debt. Any debt you must repay within the next 12 months is considered a current liability. Debt with a repayment period longer than 12 months is considered long-term debt. IFRS doesn’t distinguish between current and noncurrent liabilities and instead groups them together.
author image
Jamie Johnson, Senior Analyst & Expert on Business Operations
Jamie Johnson has spent more than five years providing invaluable financial guidance to business owners, leading them through the financial intricacies of entrepreneurship. From offering investment lessons to recommending funding options, business loans and insurance, Johnson distills complex financial matters into easily understandable and actionable advice, empowering entrepreneurs to make informed decisions for their companies. As a business owner herself, she continually tests and refines her business strategies and services. Johnson's expertise is evident in her contributions to various finance publications, including Rocket Mortgage, InvestorPlace, Insurify and Credit Karma. Moreover, she has showcased her command of other B2B topics, ranging from sales and payroll to marketing and social media, with insights featured in esteemed outlets such as the U.S. Chamber of Commerce, CNN, USA Today, U.S. News & World Report and Business Insider.
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